Silke Hüttel

A model of firm exit under inefficiency and uncertainty

Analyzing the dynamics of structural change of an industry is a fundamental but challenging issue in economics. Accordingly, many attempts have been made to rationalize entry and exit decisions of firms, which, in total, appear as structural change of a sector. Among the most often hypothesized determinants of entry and exit behavior are (in)efficiency and uncertainty in conjunction with sunk costs of irreversible investments. According to the efficient market hypothesis competitive superiority discriminates among firms (Demsetz 1973). In the long run inefficient firms should be driven out of the market. In fact, inefficiency seems to increase the probability of exit. Among others, Wheelock and Wilson (2000) have shown that there exists a correlation between inefficiency and exit. However,many firms that are found inefficient persist in the market (Emvalomatis, Stefanou, and Lansink 2011). Another relevant strand of literature is the real options approach. Uncertainty and irreversibility generate a value of waiting which, in turn, leads to (dis)investment reluctance and economic inertia (Dixit and Pindyck 1994). Empirical evidence of the presence of real options effects has been provided, for example by Hinrichs, Musshoff, and Odening (2008). Both aforementioned explanations of firm’s entry and exit behavior have received extensive attention in the literature, but only separately. A joint treatment of these two aspects is the topic of this paper. We derive a model of firm exit under output price risk allowing for inefficiency of firms. To the best of our knowledge the interaction of inefficiency and uncertainty has not been analyzed so far in the framework of dynamic firm models. The consideration of inefficiency into the real options approach requires to introduce a production function. We do not impose a priori specific functional forms on the production function. We derive the properties inherited to the instantaneous profit function from the original production function by using a dual Legendre transformation. This allows deriving flexibly the substitution properties of the production function among multiple inputs and multiple outputs in a general setting. We derive two classes of profit functions imposing structure on the primal technology. The difference among the classes depends on how the inefficiency is considered. In the first class, inefficiency is considered separately from inputs and outputs, and acts as a shifter. In the second case inefficiency modifies the production function, directly interacting with inputs and outputs. Specific calculations to simulate the exit trigger prices are carried out on the particular case of a Cobb-Douglas production function. In both the separable and the non-separable classes inefficiency causes firms to exit from the market earlier compared with more efficient firms. Higher volatility of output price makes more reluctant the firms to decide to exit irreversibly the market. Higher unit costs, as well as a higher salvage value, decrease the reluctance to exit the market. Calculations are done for different hypothetical returns to scale cases, a higher and a lower one without qualitative difference in the findings. But these results show that, for the same price, it is possible to have a range of firms of different levels of efficiency and different returns to scale present in the market. Our model results generate a rich set of hypothesis that can be empirically tested, for example, in the case of German dairy sector.

Estimating investment equations in imperfect capital markets

Numerous studies have tried to provide a better understanding of firm-level investment behaviour using econometric models. The model specification of more recent studies has been based on two main approaches. The first, the real options approach, focuses on irreversibility and uncertainty in perfect capital markets; of particular interest is the range of inaction caused by sunk costs. The second, the neo-institutional finance theory, emphasises capital market imperfections and firms’ released liquidity constraints. Empirical applications of the latter theory often refer to linear econometric models to prove these imperfections and thus do not account for the range of inaction caused by irreversibility. In this study, a generalised Tobit model based on an augmented q model is developed with the intention of considering the coexistence of irreversibility and capital market imperfections. Simulation-based experiments allow investigating the properties of this model. It can be shown how disregarding irreversibility reduces effectiveness of simpler linear models.

Religiosity and household income in Sekhukhune

ABSTRACT Literature analysing the interrelation of religion and economic performance suggests religion to explain differences in household income. Religious communities foster economically conducive attitudes and are important sources of social capital, particularly under weak economic structures. This paper targets at investigating effects of religiosity on rural household income using survey data from Greater Sekhukhune in the Limpopo Province of South Africa. Using insights from religious studies within a conceptual framework of rural household decision-making, the authors estimate an income equation that includes measures for religious affiliation. While church membership per se does not reveal a significant effect on household income, the results show a positive and robust relationship for membership in the Zion Christian Church and the practice of African traditional religion.

Forced Sales and Farmland Prices

We analyze farmland prices in the German federal state of Brandenburg from 2000 to 2011 with the aim to understand the price formation process in farmland foreclosures. Pressured sales usually result in a price discount due to time constraints; however, the land is sold using public auctions. This may lead to a price premium. Since the effect of a foreclosure on farmland prices is ambiguous, we empirically quantify the overall effect. We use matching techniques and a regression-based approach. We find that on average, price premiums are realized, though the effect depends on prevailing land market conditions. (JEL C21, Q11)